I like to use analogies to visualize abstract concepts.
For example, interest rates. What could be more abstract than an interest rate?
In my mind, an interest rate is like a basketball hoop. When the rate is low, it is as if the basketball hoop is one meter above the ground. Scoring points becomes easy.
A week in the South? A ski weekend in Tremblant? No problem, we’ll put that on the line of credit. Everyone is Michael Jordan when the basket is low.
The higher the basket rises, however, the more difficult the game becomes. We think twice before borrowing. We consume less, and this reduction in consumption ends up lowering inflation. Eventually, central banks can bring the basketball hoop down, and the cycle resumes.
Today, as we know, the basketball hoop is going up. Interest hurts more, and we are looking for ways to stop this pain.
One of the glaring questions is to wonder if it is not better to repay your mortgage loan more quickly, even if it means stopping saving and investing.
Is it a good idea ?
Wanting to get rid of your mortgage may seem logical: psychologically, owing nothing to the bank offers a peace of mind that no Excel workbook will ever manage to reflect. But, on a purely financial level, the dollars spent paying off a mortgage loan are probably not the best investment. And this is true even with rising rates.
This is the result of a recent analysis made by Wealthsimple. The Canadian financial company wanted to know if a portfolio of index-based exchange-traded funds (ETFs) made up of stocks and bonds were more likely to outperform the losses inflicted by the interest paid on a mortgage loan .
Assuming a 6% return on the portfolio, the calculation shows that the probability of ending up with more money has historically been greater with the choice of investing in financial markets than with paying off the mortgage, as shown the next board.
We see that the probabilities are not fixed: the longer we let our investments work, the more the chances of having a positive result increase (with a horizon of less than five years, it is better not to invest at all, because the markets are too unpredictable in the short term).
The analysis does not take into account the tax payable on the investments. And so it is to our advantage to put our investments in an account that eliminates any tax on their growth, like the TFSA.
And note that this is a conservative calculation. A balanced and diversified portfolio of Canadian, US and international equity and bond index ETFs has delivered average annual returns of nearly 9% for half a century. This is 50% more than the 6% used by Wealthsimple in its calculation.
The choice to invest has historically been the right one for someone who is willing to let their money work and not sell their investments in a stock market decline, like the one we are going through this year.
It’s counter-intuitive, but we mustn’t stop investing, even when our house is costing us more. And this, regardless of the height of the basketball hoop.
Too good to be true
I asked you last week in the newsletter what you learned in 2022. Here are some of the answers you sent me.
I remember that the year 2022 confirmed the thesis that the “flavors of the month” and the cryptos of this world are sometimes (even almost always) financially dangerous if you want to build a viable financial heritage.
Philip
I learned in 2022 that analyst buy recommendations are no better than the worst neighborhood psychic or witch. After seeing these recommendations, I bought shares of Lightspeed and Lion a year ago. They have since dumped 70% of their value.
francis
I swore to myself to respect this trinity of advice: 1. never the “flavor of the month”; 2. be wary of media or other enthusiasm for a title; 3. always and forever remember rules #1 and #2!
Alain
The newsletter will be on hiatus next week and will return on January 3. Have a Happy Holidays!